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2 Stocks That Are Wasting Your Money

And one more that isn't.

According to Boston University finance professor Allen Michel, when a company announces it's buying back stock, that stock tends to outperform the market by 2% to 4% more than it otherwise would have over the ensuing six months.

But multiple studies show that over the long term, buybacks actually destroy shareholder value. CNBC pundit Jim Cramer cites the example of big banks that bought back shares in 2007-2008 -- just before their stocks fell off a cliff. Far from buy signals, Cramer calls buybacks "a false sign of health ... and often a waste of shareholders' money." Indeed, the Financial Times recently warned: "the implied returns over a period from buy-backs by big companies would have been laughed out of the boardroom if they had been proposed for investment in ... conventional projects."

So why run buybacks at all? According to FT, management can use them to goose per-share earnings, which helps CEOs earn bonuses based on "performance." Also, the investment banks that run buybacks earn income and fees from promoting them. But you and me? Unless the purchase price is less than the shares' intrinsic value, we miss out.

And we're about to miss out again.

Procter & Gamble(NYSE:PG)Procter & Gamble surprised a lot of investors last week -- and pleasantly -- when instead of reporting the $1.11 a share in fiscal-second-quarter profit it had been expected to produce, the company announced it actually earned $1.22. P&G shares promptly popped 4% in response to the news. Sadly, what should surprise exactly no one is that now that the stock costs more, management has decided to buy more of it, saying it now plans to buy back at least $5 billion of its shares.

That's a bad decision, and I'll tell you why.

Priced at 15.5 times earnings, P&G certainly looks cheap enough, but looks can be deceiving: 15.5 times earnings is actually a bit expensive, considering that few analysts expect the company to grow its profits any faster than 8% a year over the next five years. It's also a deceptively low-looking number for two reasons: First, it doesn't take into account P&G's $26.5 billion net-debt load. (If that were counted as part of its market cap, we'd be saying P&G has a P/E of 17.7.) Second, it doesn't mention that with just $10.7 billion in free cash flow backing up its earnings, P&G actually only generates about $0.83 in real cash profit for every $1 it says it's "earning."

Oh, sure. I know I gave Nokia props last week for finally turning in an FCF-positive fourth quarter. I even expressed some hope that the company is turning itself around. Remember, though, that this is for now just a hope. And remember, too, that one FCF-positive quarter doesn't change the fact that Nokia burned cash the other three quarters of last year, and ended the year nearly $1.1 billion in the red for cash-burn. Regardless, the company promised to make all that right, and spend more than a billion dollars buying back as many as 370 million Nokia shares over the next 18 months. Of course, to find the cash to do this, Nokia had to suspend its popular dividend program.

My reaction: Thanks, but no thanks, Nokia. If it's all the same to you, I'd rather take the cash. Then, if the numbers look right, I can buy back your shares myself.

Herbalife(NYSE:HLF)Come to think of it, though, if Nokia could be persuaded to reinstate its dividend, I might actually be tempted to spend the money on another stock entirely. You see, I don't like to end this column on a down note, and fortunately, this week I don't have to. Because as it turns out, one company that's buying back shares today -- Herbalife -- actually looks like quite a good bargain.

Priced at a lowly 11.3 times earnings, but growing these earnings at upward of 15% a year (and not for nothing, paying a 2.8% dividend yield to boot), Herbalife shares look awfully tempting at today's prices.

Is the stock controversial? Is it "risky?" Sure it is. That's why hedge fund honcho Bill Ackman is shorting Herbalife. But if you ask me, the $427 million in real free cash flow this company generated over the past year is proof positive that Herbalife is for real, and its profits reliable. Unless and until that changes, I think Herbalife's entirely right to be buying back shares -- as it recently promised to do.

Unless you think the company is bald-faced lying about its cash flows, you might want to pick up a few shares, too.

Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble. The Motley Fool has the following options: Long Jan 2014 $50 Calls on Herbalife Ltd.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Author

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.